Schools of Thought
There are several schools of thought as to which credit card do you pay off first. Dave Ramsey‘s Financial Peace University recommends that you pay off the smallest debt first. His belief is that this will give you a psychological lift when you’ve paid off a debt and that you’ll reduce your stress level by having one less bill each month. Suze Orman and other financial advisers recommend paying off the highest interest credit card first. If you have two credit cards with an equal balance, paying off the one with the highest interest rate will yield the greatest savings in interest you do not have to pay over the life of the loan. Other financial advisers recommend tackling the largest debt first, because this balance will compound faster than a small, high interest loan.
Which Credit Card Do You Pay Off First?
This is dependent upon your beliefs, the cash you have on hand, the number of debts and whether or not you can pay much more than the minimum monthly payments on all of your bills.
What should you do if you have cash set aside?
Look at the size of your savings account or emergency fund. Set aside at least a thousand dollars if not three months of living expenses. Then use the rest of the cash to pay off part or all of several loans. If you have several small credit cards, you should pay those off and then close the accounts. If you have several loans of similar size, put the money toward the one with the highest interest rate.
What should you do if you can barely make the minimum payments?
If you can barely make the minimum payments, the debt snowball method Dave Ramsey recommends is best. This is because you cannot make big payments toward any debt until some of the smaller ones are eliminated. You’ll gain breathing room by putting any and all extra cash toward a small debt. When that debt is paid off, the money you paid toward that debt can be “rolled” or used to pay off the next biggest debt. After repeating this cycle several times, the $20 extra you had per month to pay off a credit card becomes $200 or $300 to put toward your car loan, student loan or biggest line of credit.
What should you do if you have several small loans and a big, high interest rate loan?
One large debt with a high interest rate will snowball into something unmanageable, whereas a small loan at a high interest rate is still easily paid with diligence and paying more than the minimum. If the one, behemoth, high interest rate loan is more than half of your debt, you should put all available cash toward this loan. If the debt hardly budges after making the monthly payment, you need to put all available money against it.
Don’t forget to stop using all credit cards during this process so that you do not run up your debt on other cards while paying off a higher balance or high interest rate card. Remember to cut your lifestyle down to tame this beast. Spending less will free up money to pay down the debt. You can resume your prior lifestyle (assuming it costs less than your take home pay) after the debt is paid.
Andrew Shultz is a freelance writer who writes about financial topics such as debt management, mortgage, short term loans .